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As the case of Paragon Trade Brands Inc. shows, the intellectual property that goes into making a diaper is not easily disposed of in bankruptcy. A Georgia judge’s ruling that Weyerhaeuser Co. had to pay Paragon Trade nearly $460 million for transgressions involving patents is providing further proof of how important intellectual property issues are becoming in bankruptcy proceedings. Judge Margaret Murphy of the U.S. Bankruptcy Court for the Northern District of Georgia in Atlanta ruled April 5 that her October 2002 decision still stood — Federal Way, Wash.-based Weyerhaeuser didn’t tell Paragon investors there were problems with the IP rights of Weyerhaeuser’s former unit — and that the forest products company must pay Paragon investors damages. In affirming her earlier ruling, Murphy rejected Weyerhaeuser’s gambit to have the award against it thrown out. “They lost on breach of warranty, then they appealed and lost that,” said Paragon’s lawyer, John Lee of Andrews Kurth. “They then asked for an interlocutory appeal, but they lost at the district court. They then asked [the bankruptcy court] to have the damages thrown out and lost again and got pounded.” IP rights involving bankrupt companies have increasingly come to the fore, thanks to the fact that federal appellate courts are at odds about how language in the federal Bankruptcy Code should be interpreted and because those courts have also been giving weight to one section of the code over the one relevant to intellectual property rights. Murphy’s affirmation, however, seems to reinforce the notion that despite the confusion at the appellate court level, IP rights and the issues surrounding them are very much the province of the nation’s bankruptcy judges. In October 2002, Murphy blasted Weyerhaeuser for telling Paragon investors there was no problem with its former unit’s intellectual property rights. Weyerhaeuser, a paper and pulp giant, created Paragon to produce disposable diapers and then spun the unit off in a February 1993 initial public offering that generated $240 million. The only problem was that four years later Judge Joseph Longobardi of the U.S. District Court for the District of Delaware in Wilmington ordered Paragon to stop selling its highly touted double-cuff diapers and pay Procter & Gamble Co. $164 million and Kimberly-Clark Corp. $115 million for copyright infringement on two patents. That ruling forced Paragon to file for Chapter 11 on Jan. 6, 1998, with the Atlanta bankruptcy court. Tyco International Ltd. bought Paragon on Dec. 3, 2001, and it then exited bankruptcy 28 days later. The following October, Murphy lambasted Weyerhaeuser over the diaper IP issue. Attorneys familiar with intellectual property rights said all of this could have been avoided had Weyerhaeuser paid closer attention. “When people do a deal, they’re not looking at intellectual property,” said Jim Woods, forensic accounting and investigative service practice leader for Grant Thornton LLP in Houston. “They’re interested in traditional measures of business success such as market potential and profit margin. “Any prospectus of deal documents usually boasts a company’s competitive advantage,” Woods continued. “IP usually doesn’t come up in that discussion, especially in non-high tech areas.” Dan Karson, executive managing director at Kroll Inc., believes that any company doing a spinoff or an acquisition must investigate the degree in which it or the target has protected their intellectual property. Companies must also review their IP coverage state by state and country by country and determine if any possible legal action lurks over the horizon, he said. Weyerhaeuser claims it did just that. “We had fully disclosed all litigation risks in the IPO prospectus, and shareholders were aware of potential of litigation,” said company spokesman Bruce Amundson. But Karson, who is not involved in the Weyerhaeuser-Paragon case, cautions that any manufacturer offering a product in a highly competitive market dominated by one or two major players should be careful — particularly if that product looks, operates or tastes like one from industry leaders. “You have to assume there is high degree of risk for allegations of infringement,” he warned. Melvin Hoffman, senior partner at Looney & Grossman, noted that it’s easy to see why a big company would spin off a risky business to protect itself. “But sometimes it can come back to haunt them,” he pointed out. This occurs when the spinoff runs up debts that it can’t pay off and the creditors come after the parent by claiming the parent tried to shield itself from liability. “In bankruptcy, it doesn’t matter what people’s intentions were or if there’s 20/20 hindsight,” said Eric Simonson, an M&A attorney at Preston Gates & Ellis in Seattle. “If it turns out there is a problem of this sort, the trustee is almost fiducially bound to bring a claim on behalf of the creditors.” Which is exactly what happened with Weyerhaeuser. And Murphy made sure it stuck. Copyright �2005 TDD, LLC. All rights reserved.

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